Indonesia’s Economic Outlook in 2018

After a year of economic dissatisfaction (See: Indonesia’s Second Semester Economic Outlook: Focusing on Investments), it is predicted that the Indonesian economy will improve, albeit slightly, in 2018. This is in-line with the expected amelioration of the global economy, including China, as well as the projected increase in domestic demand and household consumption.

The Indonesian government will rely on three sectors to drive the country’s economy in 2018: investment, consumption, and exports. Challenges, however, still remain as the country will hold simultaneous local elections in 2018, which will likely increase political tensions ahead of a national election in 2019.

Foreign investment is expected to go up as a result of three international ratings agencies, namely Fitch, Moody’s, and Standard and Poor’s (S&P), since having elevated Indonesia’s sovereign ratings to investment grade.

Modest optimism

Bank Indonesia (BI) forecasts that Indonesia’s economy will grow by around 5.1% to 5.5% in 2018, which is slightly better than its performance in 2017, which stood at 5.05%. This prediction is within the range of the government’s target in the 2018 State Budget of 5.4%, and both the World Bank’s and Asian Development Bank’s (ADB) projections of 5.3%.

The three banking institutions within Indonesia have predicted that investment, household spending, and exports will support Indonesian economic growth in 2018. Another positive aspect is that BI expects inflation in 2018 to reach around 3.5%, whilst the current account deficit will be under 3%.

This is more or less in-line with the World Bank’s inflation forecast of 3.5%, and current account deficit projection of 1.8%. Core inflation is expected to be stable, while inflation from administered prices will likely if the central and local governments are able to improve their coordination in controlling inflation through better logistics and food distribution management. This will also help maintain Indonesians’ purchasing power and ensure that consumption continues to grow healthily.

In the banking sector, the Financial Services Authority (OJK) expects credit and third-party funds to grow by around 10-12%, whilst loan disbursement is projected to improve gradually following the cut in the BI reference rate which will give flexibility to banks to manage their liquidity.

Other growth contributors in 2018 include a strong labour market, the decline in the cost of loans, as well as the improved performance of public infrastructure development, the investment climate and exports (See High Stakes for Indonesia’s New Infrastructure Push).

Aside from internal factors, external factors such as an anticipated acceleration in global economic growth from 3.5% to 3.6% and an uplift in one of Indonesia’s largest trading partners, China, along with the projected increase in several commodity prices, will likely bring about positive sentiment that should boost investment and exports. In addition to that, the World Bank predicts that 2018 will be the first year since the global financial crisis where the global economy will operate at or near its full capacity.

Moreover, the World Bank projects that China’s economy will grow by 6.4% in 2018 thanks, in part, to the relatively high growth of consumption and the service sector. Furthermore, the country will continue its efforts in eliminating excess industrial capacity and ensuring that the risks in its financial system are under control. This is important because for every 1% decline in China’s economy, Indonesia’s economic growth is cut by 0.11% (See What China’s Slowdown Means for Indonesia: A Trade Perspective).

Challenges remain

On the negative side, the Rupiah exchange rate is expected to weaken in 2018 to around 13,400 IDR to 13,700 IDR per US dollar from that of the previous year of 13,300 IDR to 13.600 IDR per US dollar. Moreover, the World Bank is predicting the tightening of global financing as well as increased trade restrictions and geopolitical tensions. In addition, there is also the potential for growth slowdown over the longer term among countries that constitute more than 65% of the global economy due to slow productivity and weak investment.

In addition, in order to maintain and boost the investment climate in the country, BI must formulate various monetary and macro-prudential policies. The Indonesian government’s continuous efforts to coordinate fiscal and monetary policies will help maintain price stability, especially from the supply side and improve productivity from the production side. Fiscal policy will support growth through budget reallocation that will give a higher spending ceiling for public infrastructure, health and education.

Another challenge is that simultaneous local elections will be held in 171 regions in 2018. The Indonesian government has asked business players not to worry about the elections citing Indonesia’s ongoing political stability. Coordinating Minister for Economic Affairs Mr Darmin Nasution has stated that he is optimistic that local elections and the Asian Games will contribute 0.2 – 0.3% to economic growth. However, the tensions and uncertainty brought about by the last presidential elections in 2014 as well as the Jakarta governor elections in 2017 make that an unlikely, albeit not impossible, prospect.

Government subsidies are another area to look out for as they continue to exert pressure on the state budget. The government is determined not to change the pricing policy given its far-reaching impact on purchasing power; especially for fuel and electricity prices. The Indonesian government allocated a subsidy of 156.2 trillion IDR in the 2018 state budget or down 16.2 trillion IDR from the draft 2018 state budget.

The energy subsidy will be used to improve closed distribution and subsidy disbursement of LPG, and the electricity subsidy allocation for 450 VA and 900 VA customers. Meanwhile, the non-energy subsidy comprises of the fertiliser subsidy of 28.5 trillion IDR, loan interest subsidy of 18 trillion IDR, tax subsidy of 10.8 trillion IDR and the public service obligation (PSO) subsidy of 4.4 trillion IDR.

On the external side, the Fed’s plan to raise its benchmark rate two to four times in 2018 into a range of 1.25% – 1.5%, which will pose a challenge to Indonesia’s economy. This is because if the Fed fund rate is increased, there will be more capital outflows from the country which could hamper investment (See Indonesia’s Fragility & The Fed).

Investment, consumption and exports to become key drivers

The Indonesian Finance Ministry has announced that the government will rely on three sectors to achieve its economic growth target in 2018, namely investment, consumption, and exports. Foreign investment, both direct and portfolio investment, is expected to go up as a result of three international rating agencies, namely Fitch, Moody’s, and Standard and Poor’s (S&P) having elevated Indonesia’s sovereign rating to investment grade (See Indonesia’s New Credit Rating: What Does This Mean for Investors?).

Meanwhile, domestic demand, in the form of investment in both building and non-building sectors as well as household spending is expected to become a major growth driver in line with stronger consumer confidence.

Exports, especially non-oil and gas products, are expected to continue their upward trend in 2018 and serve as the backbone of the country’s economy after the sector recorded a respectable performance in 2017. According to Statistics Indonesia (BPS), Indonesian exports in 2017 reached $168.73 billion USD; an increase of 16.22% compared to 2016.

According to the Ministry of Trade’s forecast, non-oil and gas exports will increase by a further 5% – 7% in 2018. Meanwhile, the contribution of oil and gas exports is expected to improve too as the World Bank forecasts that energy prices, including oil, gas, and coal, will climb 4% in 2018 (See Indonesia’s Coal Mining Sector: A Silver Lining Behind Dark Clouds).

The Indonesian government has set a production target in the 2018 state budget at 800,000 barrels per day (bpd) or down from that in 2017 of 815,000 bpd. Meanwhile, the gas target in 2018 has increased to 1.2 million barrels of oil equivalent per day (boepd) or up from 1.15 boepd in 2017 (See Overview: Indonesia’s Downstream Oil and Gas Sector).

To grow its export market, Indonesia needs to look beyond its traditional export destination countries such as China, Japan, the United States, and Europe. The Trade Ministry has been actively launching trade missions to several countries in Africa and South America in recent years including South Africa, Nigeria, Egypt, Chile, and Russia.

In 2018, these trade missions will be further expanded to India, Morocco, Kazakhstan, Taiwan, Algeria, Saudi Arabia, Vietnam, and Cambodia. This alongside the country’s other trade and export-related efforts such as the ongoing negotiations for a CEPA with the European Union, should begin to bear fruit.